TGIF 3 April 2020: Risky business : implications from COVID-19 reform

This week’s TGIF examines the recent changes to Australia’s insolvency regime, the potential implications for business and considerations for creditors in light of the impact from COVID-19.  

The Australian Government has now passed the Coronavirus Economic Response Package Omnibus Bill 2020. The bill was fast-tracked through both houses of parliament with bipartisan support on 23 March 2020 and makes significant changes to Australia’s insolvency regime over the next six months.

What happened?

In summary, the new legislation loosens the application of insolvency provisions under the Corporations Act 2001 (Cth). Key changes, from a company perspective, include:

• a six month period during which directors will not have personal liability to prevent insolvent trading, if debts are incurred in the ordinary course of the company’s business. The Explanatory Memorandum for the Bill gives the example of a director taking out a loan to move some business operations online or paying debts incurred through continuing to pay employees throughout the lockdown due to COVID-19; and
  
  
• a temporary increase to the time to respond to a statutory demand from 21 days to 6 months with the minimum threshold to issue a statutory demand increased from $2,000 to $20,000. 

The rationale for these changes is to save businesses and jobs amidst the COVID-19 outbreak by assisting Australian businesses at risk of insolvency to avoid unnecessary collapses. 

Comments

Insolvent trading

Much of the discourse which preceded, and has since followed, the announcement of these reforms has focused on the insolvent trading hiatus.  The Australian Financial Review reported on the observations of Corrs partners, Cameron Cheetham and Michael Catchpoole, shortly after details of the package were released (see here). A more detailed analysis on the effect of that aspect of the reforms is also available here. 

Statutory demands 

Whilst the insolvent trading moratorium is sensible, and may encourage spending, we also see a real possibility that the changes to the statutory demand regime will have a profound effect on the way companies do business with the potential to inadvertently cause a further ‘squeeze’ on cash.

For example, the statutory demand procedure (whilst not its intended purpose) is commonly used as a debt recovery mechanism with creditors reliant on the automatic presumption of insolvency on non-payment as a tactic to have their debts repaid. The extension from 21 days will mean that unsecured creditors have no recourse (save for initiating court action) against debtors for a period of six months and thus presents a risk debtors will not pay their creditors on time. Consequently, creditors themselves may face financial difficulties if they cannot reliably get paid and it follows many suppliers will almost certainly revise trading terms to, for example, insist on cash on delivery or retention of title style arrangements in order to reduce their financial risk.

Should this occur, companies with cash flow constraints will struggle to pay for goods and services upfront and may be unable to operate (in contrast, deferred payment on the usual 30 or 60 day terms normally allows companies to sell purchased items in the ordinary course of business and use this cash flow to pay the amount due). Alternatively, more sophisticated parties in business transactions may more frequently require either more complex payment structures (such as where the payment monies are held on express trust for the creditor) or some form of security to ensure payment (such as the ROT method referred to above). 

Unfair preferences

Separately, whilst the changes to the insolvent trading provisions will be welcomed by directors, it is unlikely they will prove to be of much comfort to creditors who continue to support the business over the next 6 months.  With it widely expected that Australia will enter a recession, and many businesses on the cusp of or already technically insolvent due to the current revenue shock, it will be challenging for creditors to rely on what is known as the statutory good faith defence in response to a liquidator’s claim for receipt of an unfair preference. 

These claims, typically made by external administrators and which target payments received by creditors from an insolvent company in the six months prior to their appointment, often see creditors being forced to disgorge payments received for goods and services supplied before a company goes under.  With the question of insolvency likely to be affirmed, creditors will be forced to argue, in order to keep the funds received during this six month window, that they did not – subjectively or objectively – consider the debtor company to be insolvent when monies came in, a defence which, we think in the current climate, will be almost impossible to meet.   

Takeaway

There has been a fundamental paradigm shift in the way corporate Australia does business and the extent of the damage from the COVID-19 pandemic remains unknown.  What we do know is that reforms such as these, albeit temporary in nature, can often have unintended consequences.  With that in mind, it may well be that the need for further reform arises as a result of the collateral damage caused by emergency measures.